Chapter 11 is a private court for international investors — and it’s got to go

Back in the 1950s, Germany signed a trade with Pakistan. Worried about investing in a country where the rule of law was uncertain, the Germans insisted on a mechanism that would allow its companies to take disputes over what they thought was unfair treatment or expropriation to special arbitration tribunals.

Rather than being run by national courts, these panels were to be run by arbitrators — essentially corporate lawyers who sit on special ad-hoc panels and are paid by the corporations who do much of the suing in a largely secret process.

And so was born the idea of “investor-state dispute settlement” or ISDS, which is now included in more than 3,000 trade agreements and could end up as a sleeper issue in the current renegotiation of NAFTA.

When the original Canada-U.S. Free Trade Agreement was signed in the 1980s, ISDS wasn’t an issue because it didn’t seem necessary. If an investor had trouble with a government decision, they had recourse to reliable, fair courts in both Canada and the United States.

But once Mexico was in the mix, things changed. The Americans didn’t trust Mexico to play fair, remembering the nationalization of the oil industry back in the 1930s.

So Chapter 11 — an ISDS system — was included in NAFTA.

(Just to clear up any possible confusion, we’re not talking here of Chapter 19, which regulates disputes over anti-dumping rules affecting commodities like softwood lumber. Canada is insisting on keeping that chapter in NAFTA. Washington wants to eliminate it.)

Curiously, Canada has been the main target of NAFTA Chapter 11 complaints and has lost the largest number of cases. U.S. companies have filed 39 claims against Canada, winning or settling in eight cases — at a cost to Canadian taxpayers of $215 million. Mexico has paid out $200 million. The U.S. hasn’t lost a single case.

Many of the Canadian cases have been launched by U.S. companies complaining about the impact of provincial laws and regulations on their operations. Ottawa has no control over what the provinces do, but because it signed NAFTA, it has to defend these provincial actions before the arbitration panels — and pay up when it loses.

In perhaps the best-known case, the Canadian government paid Abitibi-Bowater Inc. (now known as Resolute Forest Products) a $130 million settlement after Newfoundland took over the company’s hydro-electric facilities and timber rights in the province. Abitibi, which was based in Montreal but happened to have been incorporated in Delaware, said it had been denied fair and equitable treatment through Newfoundland’s expropriation.

Smart lawyers have figured out that Chapter 11 is a way to get their deep-pocketed clients another kick at the can when their cases are going nowhere in the national courts.

Critics have a lot of justifiable beefs against the ISDS system. For one thing, it constrains governments from making public policy choices on issues like the environment or health and safety. In one case, a U.S. firm which had proposed building a quarry along the Bay of Fundy in Nova Scotia was told it couldn’t proceed after environmental hearings. The company sued. In 2105, a panel of three arbitrators appointed under Chapter 11 ruled that the decision violated the firm’s right to “fair and equitable treatment.” The case is still before the courts.

Smart lawyers have figured out that Chapter 11 is a way to get their deep-pocketed clients another kick at the can when their cases are going nowhere in the national courts.

In one of the most egregious cases, U.S. drugmaker Eli Lilly claimed that Canada had violated its rights when the company failed to get two of its drugs patented under the Canadian process. So it sued the Canadian government for $500 million, claiming that its intellectual property had been expropriated. Absurd. Thankfully, that case was thrown out by a NAFTA panel.

The other problem with Chapter 11 is that it creates an uneven playing field for investors. If you’re a domestic investor and don’t like a regulatory decision, you can appeal it and go to national courts. If you’re a foreign investor, you’ve still got those recourses — but if you lose, you still have another shot with a NAFTA tribunal.

ISDS was a major subject of contention during the recent free trade talks between Canada and the European Union; it almost scuppered the deal. What has emerged is a dispute settlement system that will be a lot more transparent and will go a long way towards eliminating the conflict of interests inherent in the current arbitration system.

Looking to the example of the CETA deal with Europe, Foreign Minister Chrystia Freeland says Canada would like to see amendments to NAFTA “to ensure that governments have an unassailable right to regulate in the public interest.” Not unreasonable.

According to Patrick Leblond, a professor and trade specialist at University of Ottawa, it makes sense for Canada to reform NAFTA and include the same kind of investor-protection provisions that were included in CETA, including the ability of civil society organizations to weigh in on cases through “amicus” briefs to the panels.

“I think it will be transformed to make it more transparent,” he said.

CETA also foresees the establishment of a permanent investment tribunal made up of fully independent members from Canada, the EU and third countries. But there is no way the Americans will ever agree to establishment of a permanent super-national tribunal to replace the ad hoc tribunal system; they will see that as an infringement of U.S. sovereignty.

Yet Robert Lighthizer, Trump’s Trade Representative, has called for reforms too — including open hearings, the ability of non-governmental entities to make submissions and protection of U.S. domestic objectives, including protection of health and safety and security.

Maybe here, at least, we can end up with a win-win-win situation for all parties. Just don’t describe it that way to Donald Trump.

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